According to many studies published over the past 25 years, a significant portion of investment returns are determined by how investors allocate their assets versus security selection, market timing, and other factors, including style within asset classes (value vs. growth), and fees. Therefore, how an investor allocates their investment portfolio among stocks, bonds, and cash will play a significant role in the long-term performance of their investment portfolio.
Why is Asset Allocation Important?
Given that asset allocation of your investment portfolio is one of the most important aspects for long-term performance, what percentage of your investments should be in stocks, bonds, and cash? While there are a variety of factors that should be considered in making this decision, two of the most important factors are 1) your age, and 2) your tolerance for risk.
Age/Investment Horizon
When investors have a longer investment horizon, they can take on more risk, since the market has many years to recover in the event of a pullback. For example, an investor with an investment horizon of 30 years would typically have most of their investment assets allocated to stocks (equities). As a general rule, the younger you are, the larger the percentage of your portfolio that you will invest in equities. This is due to the longer time horizon that you have to recover from any type of stock market downturn.
Risk Tolerance
The definition of risk tolerance is “the degree of variability in investment returns that an investor is willing to withstand.” As an investor, you should have a realistic understanding of your willingness to “stomach” large swings in the stock market. Again, as a general rule, younger investors tend to have more of a tolerance for risk than an older investor due to their longer time horizon and ability to recover from a downturn in the stock market. However, this is not always the case.
Rule of 115
While it may not be perfect, a general “rule of thumb” is to take your age and subtract it from 115 in order to determine the percentage of your investment portfolio that should be in stocks (equities). For example, if you are 65 years old, this implies that 50% (115-65) of your portfolio should be invested in equities. For most people, the remainder of your investments would then be invested in fixed-income type of investments, with the majority being in bonds and some in cash for those investors at or near retirement.
While this “rule of 115” is a good starting point, it doesn’t take into account a particular investor’s risk tolerance. If a certain 65-year old investor has more of a tolerance for risk, he or she may choose to allocate more than 50% of their investment portfolio to equities. However, if a certain 65-year old investor has less of a tolerance for risk, he or she may choose to allocate less than 50% of their investment portfolio to equities. In addition, the “rule of 115” is not a good tool for an investor who is only interested in “capital preservation” and not in growing their portfolio indefinitely.
How DHJJ Financial Advisors Can Help
DHJJ Financial Advisors is a Registered Investment Advisory Firm that has been providing asset management and financial planning services to its clients since 1988. For over 30 years, our team of dedicated investment advisers has worked closely with our clients to produce unique investment portfolios designed to meet their personalized needs. DHJJ Financial Advisors is affiliated with DHJJ Certified Public Accountants and Business Advisors. If you have any questions on asset allocation or any other investment-related issues, please contact any of the financial advisors at DHJJ Financial Advisors at 630-420-1360 or fill out the form below.
